Financial Services Tax & Legal Update - June 2022 - PwC Middle East

Oman VAT guide for the Financial Services Sector

In brief

Following the introduction of Value Added Tax (“VAT”) in Oman on 16 April 2021, the Oman Tax Authority (“OTA”) issued on 26 April 2022, a new guide on the application of VAT to the Financial Services sector (the “Guide”). 

The Guide confirms that VAT exemption applicable to the supply of financial services provided by banks and financial institutions licensed by the Central Bank of Oman or any other competent authority (including persons licensed to conduct Islamic financial banking activities or life insurance activities by the relevant body in Oman) where the consideration is an implicit margin. It also gives guidance on the application of VAT at the standard rate on financial services remunerated by way of a fee, commission or discount.

The Guide covers the application of VAT to various conventional and islamic banking products as well as life insurance, transfers of equity and debt securities, insurance services, warranties, etc. The Guide also clarifies certain administrative practices which the taxable persons may follow and that should be acceptable to the OTA.

In detail

The Guide can be technically divided in the following 4 sections:

1. General clarifications for the financial services industry

2. Clarifications specific to the banking industry (including Islamic finance)

3. Clarifications specific to insurance industry

4. Administrative practices clarified in the Guide

PwC has published a detailed newsletter which can be referred for detailed updates under each of the above sections. We have included certain key updates in the following paragraphs for your information:

Real estate related supplies

• Interestingly, financing associated with the provision of real estate (under asset financing arrangement) and insurance taken out over a particular piece of property will be treated as ‘real estate related services’ and not ‘financial services’. This practice is aligned with the practice followed in the KSA, but this is not aligned with the practice followed in the UAE and Bahrain.

Compensatory or punitive charges

• The VAT treatment of compensatory or punitive fees, where the fees are typically anticipated in the contractual terms, and form part of the normal revenues received by the financial institution, are subject to VAT at the standard rate (e.g. late payment, early termination fee). However, where the compensation is awarded by a court, arbitration panel, or committee, or received to settle a dispute, the bank or financial institution is not required to charge VAT on such compensation. As such the settlement is outside the scope of VAT. 

• Specific guidance is provided on the penalty charges collected by Islamic financing providers which are typically required to be remitted to a charity; these charges are not subject to VAT. 

Waiving of customer fees

• Waiving of customer fees may not be treated as deemed supply only if conditions such as genuine commercial reasons, no reciprocal purchase of related goods, a waiver for existing customers who separately pay for other services, are met.

VAT treatment of deductible under an insurance contract

• The deductible payable by an insured under an insurance contract/ policy is not treated as a consideration for a supply by an insurance company, and as such is out of scope of VAT.

Input VAT on repairs under an insurance contract

• In cases where repair and other services are provided directly to the insured, the insurance company will not be eligible to claim an input VAT deduction in relation to payments of monetary claims to the insured. However, if the third-party contracts with and provides services directly to the insurance company, the insurance company will pay the charged VAT to the supplier. In these cases, the insurance company (if eligible) may deduct the VAT in its VAT return provided the insurer is the recipient of the services.

Provisional partial input VAT deduction percentage

• As an alternative to the quarterly calculation of the partial deduction percentage, the taxpayer can provisionally use the percentage of the previous year subject to certain conditions.

Use of exchange rates

• As per the Oman VAT legislation, a taxable person is required to use the exchange rates published by the Central Bank of Oman on the date of supply. However, the Guide provides for an administrative practice under which the taxable person may seek clarification from the OTA on alternative procedures for currency conversion.

What next

The Guide does not provide clarification on certain areas such as the value of supply that should be reported for an issue or sale of securities, speculative trading, VAT treatment of the travel insurance, invoicing requirements for interchange fee, etc. Therefore, a request for public clarification needs to be filed by the industry associations on these aspects.

How PwC can help?

PwC can assist you in identifying the gaps between the VAT treatments and compliance practices followed by you by providing you with the following services:

• We can assist in review of your VAT treatments and compliance practices followed by you in light of the clarifications provided in the Guide.

• We can assist in preparing and filing the request for further clarification on any of the aspects covered in the Guide.

• We can assist by completing a “health check” on your compliance with the requirements and, if necessary, advise on any appropriate disclosures to tax authorities.

Recent transfer pricing audits in KSA

In brief

In an increasingly interconnected world and with the Middle East’s growing role as a global investment hub, it is no surprise that transfer pricing has become a major focus area of international tax disputes in the region.  Tax authorities in the Middle East – particularly in KSA - have recently proposed major adjustments to the transfer pricing for MNCs operating in the region.  Although these audits have not focused on any one industry, the issues raised are highly relevant for many financial services groups.

In detail

When the OECD began pushing for major international tax reforms nearly a decade ago under the “BEPS 1.0” action plan, governments in the Middle East did not immediately embrace these initiatives. However, they are making up for lost time with many countries in the region now bringing their local law into alignment with the OECD guidance and becoming signatories to the latest “BEPS 2.0” initiatives which are slated to—once again--significantly reform the international tax landscape.  Moreover, tax authorities such as ZATCA have already adopted some of the concepts underpinning the latest OECD initiatives in their approach to transfer pricing audits.  As tax authorities greatly increase resources to international tax and transfer pricing, these disputes have ballooned recently and several key trends have emerged that are directly relevant to financial institutions. 

One of the focus areas of BEPS 2.0 is to ensure that “market jurisdictions” (i.e., where the customers are based) are receiving their fair share of the overall profit.  Such a concern has surfaced in different forms during recent audits whereby affiliates selling to major customers locally are remunerated on a cost-plus basis while the lion’s share of the profits from these sales are earned outside of the country.

In the financial services sector, groups often apply a cost-plus remuneration for functions that are not considered key value drivers, often including sales and marketing.  Although such a policy may be justifiable, the default position often taken by tax authorities is that there is significant value derived from the access and selling to local customers.  We therefore recommend that such pricing models are carefully reviewed and documented. 

In evaluating the transfer pricing model, it is important for groups to conduct a functional analysis as well as to map out their value chain and evaluate how the local affiliate contributes to this value chain.  Further a best method analysis should indicate why other approaches besides cost plus, such as the profit split, are not more reliable in determining an arm’s length remuneration.

Another recurring issue is around losses and who should bear them. As financial services companies invest heavily in digital products and strategic initiatives, even the most established players may have losses that are incurred in one part of the group or another.  Such cases are often quickly flagged by tax authorities who are keen to understand whether local losses are caused by non-arm’s length pricing under the group’s transfer pricing policy.  Transparency measures such as country-by-country reporting have only increased the tendency of tax authorities to bring challenges informed by financial data that may have been taken out of context. Given the sensitivity around this issue, we recommend that groups review their transfer pricing model and evaluate the appropriateness of losses borne by an entity based on its functional and risk profile.  Finally, transfer pricing documentation presents taxpayers with the opportunity to tell the story behind their financial results and it is critical to include in such documentation an analysis of any losses.

The takeaway

Tax authorities in the Middle East – particularly in KSA—have recently proposed major adjustments to the transfer pricing for MNCs operating in the region.

ATAD III and its impact on Middle East businesses

In brief

The European Commission (“EC”) has published a draft Directive on 22 December 2021 laying down rules to prevent the misuse of shell entities for tax purposes. This proposed Directive provides indicators of minimum substance for undertakings in European Union (“EU”) Member States and rules regarding the tax treatment of those undertakings that do not meet the indicators. 

The proposed Directive would apply to all undertakings that are considered tax resident and are eligible to receive a tax residency certificate in a EU Member State (subject to some specific exclusions), including SMEs, partnerships, trusts and other legal arrangements. It is likely to result in additional reporting requirements and in some cases, additional tax liabilities for those impacted. 

Although the Directive is expected to be applicable from 2024, it has a “look back” period of two years. Groups based in the Middle East which have a presence in the EU should consider the impact of the Anti Tax Avoidance Directive (“ATAD”) III and undertake an impact assessment to determine how this will impact their businesses.

In detail

Background

In May 2021 the EC published its ‘Communication on Business Taxation for the 21st Century’ with the stated aim to provide a fair and sustainable business environment and EU tax system. 

As part of this Communication, the EC pledged to tackle the abuse of entities and arrangements that have no or little substance. This latest proposal referred to as ATAD III is designed to address this. It is one of the short-term targeted initiatives proposed by the EC to ensure fair and effective taxation in the European Union and to make sure the tax burden is shared evenly across taxpayers, in such a way that does not distort internal competition. 

This proposal stems from a European Parliament request to counter the misuse of shell entities, in addition to more general requests from some Member States, business, and civil society to deal with tax avoidance. The EC undertook a public consultation during summer 2021.

All respondents noted that tax avoidance and tax evasion remain issues, including through the misuse of shell entities. However, some respondents consider that new targeted measures are premature. Based on feedback from respondents, the EC has noted that entities can be set up with low economic substance for valid reasons and that the proposed directive is designed only for entities set up for the purposes of tax avoidance and evasion and that do not perform any actual economic activity.

Why are these rules important?

The rules are important for companies operating in the EC to determine whether they are compliant with the requirements of the minimum substance as set out by the proposed directive in order to determine if they are eligible to obtain a tax residence certificate in the respective EC countries. For large groups this may have an impact on their tax policies and the ability to obtain credit under double tax agreements between the respective jurisdictions. 

What is the scope of the rules?

The proposed Directive provisions apply to all entities that are eligible to receive a tax residency certificate in any of the EU member states and are undertaking any economic activity. This includes any other legal arrangements and structures that are deemed residents for tax purposes in a Member State. 

The Directive is not applicable to entities in third countries and as such the entities based in the Middle east are not likely to be affected directly by the directive.

In the case of payments to/from a deemed shell entity and a third country, the allocation of taxing rights should be determined by existing double tax agreements. Certain entities have been derogated from the rules and are not required to demonstrate that they meet the minimum substance test. These include: 

• A company with a transferable security listed on a regulated market or multilateral trading facility, 
• An entity that is a regulated financial undertaking (as defined in the proposed Directive).

What is the scope of the rules?

• Undertakings that hold shares in operational businesses located in the same Member State as the entity’s shareholders or ultimate parent entity, or 
• An undertaking that has at least five full-time employees exclusively carrying out the income-generating activities of the undertaking.

What are the rules to apply the minimum substance test?

Under the proposed directive there are three main criteria, also referred to as “gateways” which determine whether an entity is at risk of being considered a shell company. An assessment of whether an entity is “high risk” will be done cumulatively on the basis of whether:

More than 75 percent of the entity’s revenue in the previous two years was in the form of “passive income.” These income sources include interest, dividend, royalties and capital gains on shares and other such sources which are identified as “relevant income” for the purpose of this proposed Directive.

More than 60% of the entity’s relevant income is passed on to foreign entities through cross-border arrangements.

The administration of day-to-day operations and decision-making on significant functions have been outsourced.

How do you demonstrate minimum Substance?

Where an entity is identified as being “high risk” it will be subject to certain reporting obligations as part of its annual tax returns. In order to demonstrate that they meet certain indicators of minimum substance the entity will need to demonstrate that:

• It has its own premises, or premises for its exclusive use;
• It has its own active bank accounts in the EU; and
• It meets one of the following indicators:
  • having at least one qualified director who is a tax resident in the same Member State or sufficiently close to the undertaking and who is dedicated to its activities; or
  • the majority of full-time employees engaged with the entity’s core income generating activities are tax resident in the same Member State as the undertaking or sufficiently close by.

Where an entity is unable to demonstrate all of the above requirements it is presumed to as not meeting the requirements of minimum substance. However, an entity may be able to rebut this presumption by evidencing the following:

• Commercial rationale of setting up an entity 
• Employee profiles and the level of their experience
• Concrete evidence that the decision making takes place in the Member State where the entity is established

Where an entity is able to provide a positive rebuttal, the Member State may allow the submission to be valid for one year or an additional 5 years after the first year (6 years in total).

Timeline

Although currently in a proposal form, once adopted, this proposed Directive should be transposed into national law by the Member States before 30 June 2023 to come into effect from 1 January 2024. 

Implications for Middle east businesses

Businesses operating in the Middle East may have group entities and operations in the EU are which are likely to be impacted by the implementation of the Directive. 

Middle East group companies’ if caught by the rules should determine the implications on their entities based in the EU.

Failure to comply with the minimum standard test could result in the non-issuance of a tax residence certificate to these group entities based in the EU and this may have an impact on businesses in the Middle east particularly where double taxation relief is being claimed with respect to taxes paid in the EU.

Key takeaways

The proposed Directive is likely to have a large impact on both commercial and personal undertakings that are in scope. When an entity is unable to demonstrate that it meets the minimum substance requirements, the relevant Member States may refuse to issue a Tax Residence Certificate to such entities or issue a Tax Residence Certificate which prescribes that the certificate cannot be used to obtain the benefits of double taxation relief. 

This Directive is likely to place significant additional administrative burden this process will place on both the taxpayer and the tax authorities. This will create an added layer of complexity that all EU resident, and many non-EU resident, entities will need to consider.

The Directive is expected to be applicable from 2024. However, considering that the Directive will look back two years to determine whether the minimum substance requirements are met, entities need to start preparing to meet these requirements in advance.

Next steps

Middle east businesses should determine whether any group entities could be inscope of the ATAD III requirements and identify:

• Whether they fall within the definition of entities which are in scope for the Directive;

• Whether they have any reporting obligations under the Directive;

• Whether they are likely to meet the requirements of the minimum substance test;

• What further information and documentation will be required to report under the Directive.